Guidance expected in two months on how to conform to credit-loss reporting * Accountants, banks, analysts, regulators working on answers to compliance questions.
(Bloomberg Law) — Accounting firms and their clients in banking, finance, and other industries continue to search for answers about how to carry out new rules for earlier reporting of credit losses on financial instruments.
Banks, businesses, preparers of financial statements, regulators, auditors, and investors all have an interest in how the Financial Accounting Standards Board’s June 2016 rules (ASU 2016-13, ASC 326) will be applied as their 2020 effective date approaches.
All have been working collaboratively “to get the questions out on the table” in the early phase of the credit loss standard’s implementation, said Frederick Currie, a partner at the PricewaterhouseCoopers LLP national professional services practice in Florham Park, N.J., who works on financial instruments.
The work should yield some of the first pieces of guidance on the rules in the next couple of months, as disagreements over unanswered questions are hammered out through the FASB Transition Resource Group on Credit Losses and American Institute of CPAs forums, Currie said in a Dec. 4 roundtable discussion by the Ross Institute of Accounting Research at the New York University Stern School of Business.
“To date, I would say it’s been a very collaborative effort,” Curry said. “The FASB has been more than willing to listen to people’s questions and issues.”
The new rules, relying on a current expected credit loss (CECL) model, might cause thousands of banks to book reserves earlier against potential losses on loans and credit instruments than under current rules. Those rules look back to recognize losses only when they have been incurred, are probable, or can be reasonably estimated.
The new reporting regime represents the biggest accounting change for banks in decades, and one with potentially large financial reporting effects. “This is one of the biggest standards in a long, long time,” Currie said.
The rules pose significant modeling challenges, as they must be applied to “a dramatic array of assets,” Currie said. The asset classes, he said, include consumer loans, credit card loans, residential mortgages, commercial loans, and leases.
The modeling issues will differ by asset class. The classes have some commonalities but also differences in risk, he said. The model has to be adapted to the risk, but questions remain how to make the model practical, feasible, and transparent, he said.
A big open question is how broadly or narrowly institutions must set aside reserves for zero credit losses, or loans expected to be repaid in full, Currie said. That’s a judgment question under the standard, so it probably won’t get fully resolved, he added.
Guidance Not Prescriptive
The likely answer, Currie said, would consist of guidance identifying factors to consider, but not in a prescriptive way.
A number of other accounting and valuation issues also will probably be resolved that way, he added. “The prescriptive guidance model doesn’t fit,” he said.
The new standard calls for modeling that combines a reasonable and supportable forecast-“a new concept for us”-with a reversion to historical data when the forecast is no longer reasonable and supportable, said Kevin P. Guckian, a partner in the Ernst & Young LLP national practice group in New York.
“A lot of implementation issues have come up on how these elements fit together,” Guckian said. “You must have a reasonable and supportable forecast, but there are no bright lines on how far you have to go out with it.”
Disagreements remain over whether the historical data in the reversion period can be adjusted to reflect economic conditions in different relevant cycles, he said.
Some people maintain that the standard is clear that modelers can’t adjust the data or choose an economic time frame, but others argue that an estimate should be reasonable and supportable in the general sense of the word, using a range of all available information, Guckian said.
“You have to consider all these factors in the context of the entire estimate, and think about it holistically,” Guckian said.
Change Credit Risk Length?
Debate also continues over whether loan extensions, renewals, or modifications should be considered in measuring the contractual life of a loan, and thus the length of the credit risk, Guckian said. Most of the discussions about the standard have focused on banking, but the standard’s scope is wider, Guckian told Bloomberg Tax on the sidelines of the NYU session.
“The biggest impact is on financial institutions, but it affects all commercial entities with accounts receivable,” he said.
Those entities may lack the resources to conduct the needed modeling, Currie said during his presentation.
Stock Analyst View
Equity analysts see several advantages to the CECL model but still have concerns and unanswered questions, said Jason M. Goldberg, a Barclays Plc managing director in New York who follows the large capitalization bank industry.
The CECL model is getting attention from equity investors, “though we believe investors do not fully appreciate the magnitude of this change,” Goldberg said.
Among the concerns he enumerated are how analysts should adjust for the model in comparing banks using varying, divergent economic outlooks to measure their loan expectations, and how regulators at the Securities and Exchange Commission will view reserves set aside for future downturns.
Also, he said, larger regional banks have expressed concerns to the SEC that the new model’s “concepts are inconsistent with the economies of lending by requiring banks to recognize estimates of future expected credit losses immediately, while the related revenues are recognized over the lives of the underlying loans.”
They believe immediate recognition of expected losses would hurt credit, weighing on the economy, and also accelerate cyclical economic downturns and delay recoveries, he said.
Stock analysts are watching to see whether the shift in the U.S. regulatory tone will have an impact on the new standard, despite FASB’s independence, Goldberg said.
He noted that a June Treasury Department white paper on reducing bank regulation urged a careful review by regulators of the standard’s impact in banks’ capital levels.
He added that the Federal Deposit Insurance Corp. and the Office of the Comptroller of the Currency, in October, said that they are considering whether to make adjustments to capital rules to account for the impact of the new model.
Defending the standard, which he called “a trust-but-verify model,” FASB Member Hal Schroeder said that the CECL approach changes only the timing of loss recognition, not the actual loss itself. It’s much more consistent with the way bank risk managers on the ground think about loss recognition, he said. The goal has been to develop “a consistent way of thinking about this issue, in a cost-beneficial way,” Schroeder said. “If changes are needed, FASB is open to that.”
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